Closing stock is shown on the credit side of the trading account and under the head current assets in the balance sheet. Now, Moving on-to the accounting treatment of closing stock followed by reasons and a sample practical example. Accounting Treatment of Closing Stock- According to accounting concRead more
Closing stock is shown on the credit side of the trading account and under the head current assets in the balance sheet. Now, Moving on-to the accounting treatment of closing stock followed by reasons and a sample practical example.
Accounting Treatment of Closing Stock-
According to accounting concepts and principles, every accountant should record closing stock/inventory and other current assets (say- short-term investments, marketable stocks and securities) as per the conservatism (or) prudence concept.
This concept states that closing inventory (or) other current assets must be recorded at Cost (or) Net Realizable Value (NRV) whichever is the least. Conservatism concept follows a rule that “never anticipate for future profit but the record for all possible losses occurring in an organization”.
Example- At the end of the financial year, if the value of closing stock in the books appears to be 45,000 but, its market value is 60,000. Then the surplus amount 15,000 (60,000-45,000) will be treated as anticipated profit that will be obtained when the stock is sold in the next accounting period.
According to the principle of conservatism, the closing stock must be valued at cost or Net Realizable Value (NRV) whichever is least. Hence Closing stock must be valued at 45,000 in the books of accounts.
Reason for showing closing stock on the credit side of trading account-
Closing stock is shown on the credit side (revenue side) of the trading account but closing stock is not revenue. It is just shown on the revenue side because of the application of matching concept which states that “all expenses must match with the revenues of the current period”.
The value of an opening stock, purchases and direct expenses is charged as an expense to the trading account by showing them on the debit side. The income produced by selling them is matched by showing it as sales, direct revenue on the credit side of trading account.
Hence, if there are any unsold units left with the organization, then their cost should not be charged to the trading account. Further, their value must be reduced by recording them on the credit side of the trading account to find true or genuine gross profit.
I would further like to add an example to make the above explanation easy and understandable.
Example- ABC Co. purchased 150 units of goods for 50 per unit. After a few months, they sold 100 the units for 100 per unit. Calculate the value of Gross Profit based on given two cases.
Case 1- If the Closing stock is not shown on the trading account
Case 2- If the Closing stock is shown on the trading account.
Case 1- If the closing stock is not shown on the credit side
In case 1, total revenue of the firm = 10,000 (sales) is matched with total expenses of the firm = 7,500 (purchases) then the gross profit will be 2,500 (10,000-7,500). This gross profit is untrue because the accountant has violated the matching principle of accounting by not recording 50 unsold units as closing stock.
Case 2- If the closing stock is shown on the credit side
In case 2, total revenue of the firm = 15,000 (sales + closing stock) is matched with total expenses of the firm = 7,500 (purchases) then the gross profit will be 7,500 (15,000-7,500). This gross profit is true (or) genuine because the accountant has followed the matching principle of accounting by recording 50 unsold units as closing stock.
A snippet of trading account will help you to develop a better understanding of the concept
For anyone who is not familiar with the term 'closing stock', in brief, it refers to the unsold goods held at the end of the financial year. To ascertain the true financial position of a company it is necessary to adjust the closing stock at the end of an accounting year. Adjustment entry of closingRead more
For anyone who is not familiar with the term ‘closing stock’, in brief, it refers to the unsold goods held at the end of the financial year. To ascertain the true financial position of a company it is necessary to adjust the closing stock at the end of an accounting year.
Adjustment entry of closing stock
The closing stock generally does not appear in the trial balance and is seen as an adjustment entry. We need to pass an adjusting entry before the preparation of final accounts. It is important to note that an adjustment entry is always recorded twice in the books of accounts therefore, the two ways of recording the same for closing stock are as follows:
1. Credit side of the trading account.
2. The asset side of the balance sheet.
Example
The closing stock of ABC Ltd. amounts to 40,000. The journal entries in the books of the company are as follows:
(being closing stock adjusted)
Placement of closing stock in the trading a/c
Placement of closing stock in the balance sheet
Note: Sometimes, adjusted purchases are given in the trial balance which indicates that the opening as well the closing stock have been adjusted through purchases. It is important to note here that the closing stock will only be recorded on the asset side of the balance sheet and will not appear in the trading a/c.
Hope this helps.
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